For many investors in the life settlements asset class (the purchase of a life insurance policy in the secondary market as an investment), one of the primary concerns is access to leverage. Because life settlements are a negative carry asset (i.e. premium must be paid to keep the life insurance policy in force to maturity), the need for leverage is particularly acute. Logically, a life settlement, which has characteristics very similar to a zero coupon bond, should be an attractive asset for lenders. Life settlements are purchased for a fraction of their face value and, assuming reasonable loan-to-value ratios, a lender should be comfortable that its loan is fully secured. However, with certain notable exceptions, major financial institutions have been unwilling to make loans secured by life settlements. In those few instances in the past in which a significant line of credit was extended, the bank has often ended up foreclosing on the collateral and (reluctantly) owning a portfolio of life settlements. As a result, the ability of an owner of a portfolio of life settlements to obtain leverage using life insurance policies as security for the loan has been all but non-existent for the last several years.
Why have banks ended up foreclosing on these portfolios? There are several reasons, chief among them being that the life expectancies of the insured lives under many of the policies purchased with prior lines of credit secured by life settlements turned out to be grossly underestimated, or the policies were purchased from questionable finance programs, thus casting doubt on the value of life settlements as collateral for a loan.
It is now 2013, life expectancies have gone through several adjustments, and most of the policies that originated via questionable programs have either lapsed or are now at least half a decade old and unlikely to be challenged by an insurer. Is it time for financial institutions to start lending again using life settlements as collateral to secure the loan? The answer is yes, but carefully. While life settlements do not necessarily have inherent value, a properly and carefully originated portfolio of life settlements does have significant value and is an ideal asset for use as collateral to secure a loan. Indeed, it appears that some smaller, non-institutional lenders have recognized that life settlements can be excellent collateral for loans and have entered into revolving lines of credit secured by the purchased policies, albeit at interest rates that reflect a premium for the additional perceived risk. As lenders experience success with these programs, it is inevitable that major financial institutions will see the opportunity and create mainstream life insurance-backed lending programs which will drive down interest rates and give investors in the asset class the ability to leverage their assets.
James W. Maxson is a Partner in the firm's Insurance and Reinsurance Practice and Co-Chairs the firm's Life Settlements Practice. Mr. Maxson concentrates his practice in corporate and regulatory matters for the life settlement industry, as well as focusing on mergers and acquisitions and securities transactions. Mr. Maxson received his bachelor's degree from Denison University and law degree from Ohio State University.